Edited version of private ruling

Authorisation Number: 1011585188171

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Ruling

Subject: Assignment of future partnership interest

Question 1

Did a CGT event E9 arise upon the execution of agreement B?

Answer:

No

Question 2

Did CGT event D1 occur upon the execution of the agreement B?

Answer:

Yes

Question 3

If CGT event E9 does arise will there be no CGT event arising as a consequence of you affecting an assignment of a share of your partnership interest in the new partnership?

Answer:

Not Applicable

Question 4

If no CGT event E9 arises, will a CGT E1 event arise as a consequence of you and your spouse entering into the assignment of some of your interest in the new partnership?

Answer:

Yes

Question 5

If you are a member of the new partnership for more than 12 months prior to effecting the assignment will the 50% discount provided by Division 115 of the ITAA 1997 apply to the capital gain which arises on entering into the assignment?

Answer:

Yes.

Question 6

If you satisfy the basic conditions for relief in Section 152-10 of the ITAA 1997, will the capital gain made by you on entering the assignment qualify for the small business 50% reduction provided by Subdivision 152-C of the ITAA1997?

Answer:

Yes.

Question 7

If you satisfy the basic conditions for relief in Section 152-10 of the ITAA 1997, will the capital gain made by you on entering the assignment qualify for the small business retirement exemption provided by Subdivision 152-d of the ITAA1997?

Answer:

Yes, provided the retirement provisions are met.

Question 8

Will Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the tax benefit obtained by you through entering into the assignment of some of your in the new partnership?

Answer:

No

This ruling applies for the following periods:

1 July 2007 -30 June 2008

1July 2008 - 30 June 2009

1 July 2009 - 30 June 2010

1 July 2010 - 30 June 2011

The scheme commences on:

1 July 2007

Relevant facts and circumstances

You were member of a partnership (partnership no. 1) until you retired from the partnership due to ill health.

You entered into an agreement (agreement 1) with your spouse assigning some of your partnership interest in partnership no. 1. Your spouse paid consideration for this assignment.

This Deed of Assignment forms a part of these facts.

As a part of this agreement, you agreed not to; 'sell, transfer, assign or otherwise dispose of' your share in the partnership without your spouse's written consent.

Prior to your retirement from partnership 1, you and your spouse executed a document (agreement 2) agreeing to your retirement.

In this document, your spouse asserted their right to their share of your interest in the partnership and made their agreement conditional on the following;

'If you recover from your current serious illness and is fit to resume work as a partner then your spouse will contribute their share of assets received, towards the new partnership, and will be entitled to their share of your new partnership income'

You have recovered from your illness and have recommenced your practice and has been invited to become a member of another partnership.

It is your intention to assign an interest in this new partnership to your spouse. A copy of the proposed agreement 3 forms a part of these facts.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 104-35

Income Tax Assessment Act 1997 subsection 104-55(1)

Income Tax Assessment Act 1997 subsection 104-55(5)

Income Tax Assessment Act 1997 subsection 104-105(1)

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 subsection 110-25(2)

Income Tax Assessment Act 1997 section 112-20

Income Tax Assessment Act 1997 subdivision 116-30(2)

Income Tax Assessment Act 1997 subdivision 115A

Income Tax Assessment Act 1997 subdivision 152-A

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-205

Income Tax Assessment Act 1996 subsection 177C(1)

Income Tax Assessment Act 1936 subsection 177D

Income Tax Assessment Act 1936 section 177F

Reasons for Decision

Question 1

E-9 event

Subsection 104-105(1) of the Income Tax Assessment Act 1997 (ITAA 1997) states that;

1. CGT event E-9 happens if;

a. you agree for consideration that when property comes into existence you will hold it on trust; and

b. at the time of the agreement, no potential beneficiary under the trust has a beneficial interest in the rights created by the agreement.

For CGT event E-9 to happen the agreement must be an agreement to hold property, when it comes into existence, on trust. At the time of the agreement, there must be no potential beneficiary under the trust who has a beneficial interest in rights created by the agreement.

Prior to considering the first limb of the test found in paragraph 104-105(1)(a) in this particular case it is useful to examine the second test found in paragraph 104-105(1)(b) and its application to your spouse as a potential beneficiary of the trust.

Agreement 2 entitles your spouse to a share of your partnership income if you become fit to resume work as a partner. When you derive partnership income, under the agreement, your spouse will acquire a beneficial interest in a share of that income. Assuming that the agreement does create a trust over property in accordance with 104-105(1)(a) your spouse will also be a potential beneficiary under the trust.

An E-9 event will not occur because your spouse is a potential beneficiary of a trust if created and also has rights created by the agreement 2 in your future partnership income.

Question 2

According to subsection 104-35(1) of the ITAA 1997 CGT event D1 happens if you create a contractual right or other legal or equitable right in another entity.

Paragraph 104-35(5)(b) states that a CGT event does not happen if the right requires you to do something that is another CGT event that happens to you.

For example when selling land a contractual right to enforce completion of the contract is generally created on exchange. The completion of the sale results in a CGT event A1 therefore CGT event D1 does not happen.

Agreement 2 subject to Agreement 1

You have argued that Clause 2 of the agreement 1 required you to hold interest in subsequent partnerships on the terms of assignment in agreement 1.

In IT 2608 at paragraphs 9 - 14 the Commissioner considers the dissolution of a partnership and the effect of this dissolution on an Everett style assignment. The Commissioner based his consideration of this issue on clauses normally associated with such an assignment. In particular paragraph 10 states;

Similarly deeds of assignment have included a clause which authorises the assignor as trustee to reinvest the assigned portion of a partnership interest in a new partnership should the existing partnership be dissolved or reconstituted for any reason.

Clause 2 of agreement 1 is not an authority for you to reinvest the assigned portion of the partnership interest should the partnership be dissolved as considered in IT 2608, rather it places a limit your ability to dispose of your share in the partnership without the written consent of your spouse. As agreement 1 does not authorise you to reinvest your spouse's portion of the partnership interest, any future agreement which purports to assign a portion of an interest in a partnership is not subject to agreement 1, but is a separate agreement between you and your spouse.

Agreement 2 differs from agreement 1 in that there was no assignment of the partnership interest. It is not an interest in the partnership that is held in trust for your spouse rather, the document creates an obligation that you pay a share of the income from a new partnership you receive to your spouse.

When you entered into this agreement you created a legal or an equitable right enabling your spouse to receive a share of the income of a future partnership satisfying subsection 104-35(1) of the ITAA 1997.

The right requires you to pay a share of the income you receive from the partnership to your spouse provided they contribute their share of the original partnership interest. These payments are not CGT events therefore CGT event D1 occurred when the agreement 2 was executed.

Your spouse

Your spouse has also created a contractual right in agreeing to contribute their share of assets received from the dissolution of partnership 1. A D1 event has also occurred for them when the agreement 2 was executed.

General Guidance - ordinary income

Under section 6-5 of the ITAA 1997, your assessable income includes income according to ordinary concepts. As a partner, when you receive profits derived from the net income of a partnership you are deriving assessable income.

Applying this to the circumstances which will occur if you enter into a partnership while subject to the agreement 2, you will derive assessable income from the partnership which will form a part of your assessable income.

You, being subject to the agreement 2, will then assign a share of your income from the partnership to your spouse. Your spouse may also be required to include this amount as assessable income.

Question 3

A CGT E9 event did not occur therefore this question is not applicable.

Question 4

Subsection 104-55(1) of the ITAA 1997 states;

CGT event E1 happens if you create a trust over a CGT asset by declaration or settlement.

None of the exceptions found in subsection 104-55(5) of the ITAA 1997 applies to your situation.

Section 108-5 of the ITAA 1997 provides the definition of a CGT asset as any kind of property or a legal or equitable right that is not property. An interest in a partnership is specifically mentioned as a CGT asset in subsection 108-5(2) of the ITAA 1997.

In your case you wish to assign a share of your proposed partnership for consideration. As discussed in Question 1, when a partnership interest is assigned to someone outside of the partnership a trust is settled over this partnership interest. You will create a trust over the share in the new partnership you assign to your spouse. A CGT event E1 will therefore occur.

Under section 104-55(3) of the ITAA 1997 you make a capital gain if the capital proceeds from the creation are more than the asset's cost base.

Capital Proceeds

Subdivision 116-30(2) of the ITAA 1997 states that the capital proceeds are replaced by the market value of the CGT asset if the capital proceeds are more or less than the market value of the asset and you and the entity that you acquired the asset from did not deal with each other at arm's length in connection with the event.

You will receive an amount from your spouse in consideration for entering into the agreement. They will not enter into the agreement at arm's length therefore if the market value of the share of the partnership is more or less than the amount you receive, the capital proceeds from the event will be the market value of the interest assigned.

In Taxation Ruling IT 2540, when discussing the market value of a partnership interest, the Commissioner examines the findings of the court in Reynolds v. Commissioner of State Taxation (WA) 86 ATC 4528. At paragraph 28;

Where an Everett assignment is not made at arm's length, the valuation method adopted in Reynolds' case will usually be the appropriate method for determining the market value of the assigned partnership interest for the purposes of Part IIIA. Broadly, this will involve the determination of the price that a "hypothetical buyer" would pay for the assigned partnership interest having regard to the value of the right to the future income of the partnership which is attached to the interest.

In order to work out the capital proceeds of the assignment to your spouse, consideration will need to be given to the value of the partnership interest. This consideration will need to include the value of the right to future in of the partnership.

First element of your Cost Base

The cost base of an asset consists of five elements. The first element of the cost base under subsection 110-25(2) of the ITAA 1997 is the sum of;

· money you paid, or are required to pay, in respect of acquiring the asset and

· the market value of any other property you gave or are required to give, in respect of acquiring the asset.

In your case the first element of the cost base will be the amount you have paid for your interest in the partnership.

First element of your spouse's Cost Base

According to subsection 112-20(1) of the ITAA 1997 the first element of the cost base of an asset is its market value if you are not dealing at arms length. Subsection 112-20(2) does not apply to your spouse's circumstances. The first element of your spouse's cost base is the market value of the share of the partnership which will be equal to the capital proceeds attributed to the partnership interest as detailed above.

Question 5

Under subdivision 115-A of the ITAA 1997, if the CGT asset was acquired 12 months before the CGT event a capital gain made by an individual is generally discounted by 50%.

In your case you will be able to discount your capital gain by 50% if you have been a member of the new proposed partnership for at least 12 months prior to agreeing to assign part of your interest in the partnership to your spouse.

Question 6

Section 152-205 of the ITAA 1997 states that you can reduce your capital gain on the disposal of an asset by 50% if the basic conditions in subdivision 152-A of the ITAA 1997 are met. There are no further conditions to be met to claim the small business 50% reduction.

You have asked us to assume that you satisfy the basic conditions found in section 152-10 of the ITAA 1997. If you do satisfy the basic conditions then you will be eligible to claim the 50% reduction.

Question 7

According to the advanced guide to capital gains tax concessions for small business 2008-09, the Commissioner considers that you can disregard all or part of a capital gain if you;

· satisfy the basic conditions in Subdivision 152 - A of the ITAA 1997; and

· you keep a written record of the amount you choose to disregard; and

· if you are under 55, you make a personal contribution equal to the exempt amount to a complying superannuation fund or retirement savings account.

The amount of the capital gain that you choose to disregard must not exceed your CGT retirement exemption limit. An individual's lifetime CGT retirement exemption limit is $500,000 reduced by any previous CGT exempt amounts you have disregarded under the retirement exemption.

In your case you have asked us to assume that you satisfy the basic conditions. If you are over 55 you can choose to disregard a capital gain up to the amount of your retirement exemption limit provided you keep a written record of the amount you choose to disregard.

If you are under 55 you can choose to disregard a capital gain up to the amount of your retirement exemption limit provided you make a personal contribution equal to the exempt amount and keeps a written record of the amount you choose to disregard.

Question 8

Unless otherwise indicated all legislative references in this question refers to the Income Tax Assessment Act 1936.

Part IVA of the Income Tax Assessment Act 1936 (Part IVA) contains general anti avoidance provisions. This part applies when an entity has obtained a tax benefit by entering into a scheme for the dominant purpose of obtaining a tax benefit.

Section 177D states that Part IVA may apply to a scheme where a taxpayer has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme.

Subsection 177C(1) defines four kinds of tax benefit, relating broadly to;

(i) an amount not being included in the assessable income of the taxpayer;

(ii) a deduction being allowable to the taxpayer in relation to a year of income;

(iii) a capital loss being incurred by the taxpayer;

(iv) a foreign tax credit being allowable to the taxpayer

In your circumstances an amount that you would have, but for the assignment, included in your assessable income from the proposed partnership will not be included in your assessable income. Instead, your spouse will include this amount in their assessable income. There is a tax benefit for you that is in connection with the scheme.

As discussed above in question 4 a capital gain event also occurs when you assign an interest in the partnership to your spouse. As a consequence of this disposal a capital gain will be incurred by you.

Dominant Purpose

When determining whether Part IVA applies to a situation it is necessary to determine whether the scheme was entered into for the dominant purpose of obtaining a tax benefit. Section 177D requires eight factors to be considered when determining the dominant purpose of the transaction. These are;

(i) The manner in which the scheme is carried out

(ii) The form and substance of the scheme

(iii) The time at which the scheme was entered into and the length of the period during which the scheme was carried out.

(iv) The result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme.

(v) Any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme

(vi) Any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme

(vii) Any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out

(viii) The nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi)

The consideration of these eight factors involves comparison of the scheme with an 'alternative hypothesis'.

The alternative to you assigning a share of your partnership interest to your spouse would be you retaining all of your partnership interest.

Broadly, the consequences of this arrangement would be;

· all of the assessable income from your interest in the partnership would be assessable income for you.

· No capital gain would be payable by you as no CGT event E1 occurred at this time.

· Your spouse would not have an indefeasible interest in the partnership.

· Your spouse would not have the right to receive any of the income from the partnership and will not gain any assessable income from the partnership interest.

Factors 1- 3 - How the scheme was implemented

The assignment of the partnership interest will be carried out via a Deed of assignment. The Deed requires your spouse to pay consideration in return for a share in your interest in the partnership. The Deeds purpose states;

The Assignor wishes to make provision for the Assignee's financial well-being and is desirous of assigning a share of your interest in the Partnership to the Assignee

Under the agreement you cannot terminate the partnership without the agreement of your spouse. Following any termination of the partnership should you enter into another medical partnership you are required to hold an interest for your spouse.

The agreement acknowledges section 31 of the Partnership Act 1892 (NSW) which limits your spouse's rights in the partnership to the receipt of income and prohibits them from interference in the management or administration of the partnership business.

The Deed will either be entered into at the time you enter the new partnership or alternatively 12 months after you enter into the partnership. There is no end date to the agreement.

In substance the agreement creates a stream of income for your spouse that operates outside of your control.

The agreement also operates so that your assessable income is reduced by the amount payable to your spouse.

Factors 4-7 - the effect of the scheme

The effect of the scheme will be;

· Your assessable income produced from the partnership being reduced.

· Your spouse's assessable income increased.

· A CGT E1 event will occur in relation to the assignment of the partnership interest. Your capital proceeds for this event will be based on the market value your partnership interest. According to IT 2540 a market value of a partnership interest will include a calculation of the market value of future income from the partnership while the cost base of the asset will be based on the amount you pays to acquire your interest in the partnership. This suggests that you will make a capital gain from the assignment and will be subject to the capital gains tax regime upon assignment.

· The scheme in effect creates a non-revocable interest in your share of the partnership which is assigned to your spouse. While your spouse cannot interfere in the management of the partnership, you cannot take back the interest once it is assigned.

Factor 8 - the nature of the connection between the taxpayer and any other person

According to paragraph 111 of Practice Statement Law Administration PS LA 2005/24,

Many dealings which would be decidedly odd between strangers may be entirely explicable between family members.

While the assignment of an interest in a partnership may be difficult to explain between strangers, the assignment between spouses could be explained by the desire to set up an independent source of income as is indicated in the draft deed of assignment.

Conclusion

The Draft Deed of Assignment (2010 Deed) provides for the assignment of an interest of your yet to be determined interest in the partnership to your spouse for consideration of $10,000. There is no revocation clause in the agreement and future Partnerships will be subject to this assignment.

While your assessable income will be reduced, your spouse will be liable to pay the income tax because of the assignment of the partnership.

You will also be liable for capital gains tax under Part 3-1 and subject (if eligible) to Part 3-3 of the ITAA 1997.

These factors may, in effect, balance the benefit you receive through the reduction of future assessable income arising from the assignment.

According to Taxation Ruling IT 2501 at paragraph 9;

valid assignments on all fours with the Everett or Galland decisions will be accepted for tax purposes and will not be regarded as caught by section 260 or Part IVA

This Deed is similar in form and effect to the deed of assignment that was the subject of Federal Commissioner of Taxation v Everett (1980) CLR 440 and Federal Commissioner of Taxation v Galland 86 ATC 4885 and as such would be on all fours if executed.

According to IT 2501 the Commissioner considers that such assignments will not be caught by Part IVA of the ITAA 1936.